Lecture Health economics - Chapter 10: The hospital market (Part 2)

The Hospital Market, Part 2

Professor Vivian Ho
Health Economics
Fall 2007


Structure: Putting it all Together
Is the hospital market competitive, or not?
Case Study:
UNITED STATES OF AMERICA, Plaintiff,
vs. MERCY HEALTH SERVICES and
FINLEY TRI-STATES HEALTH GROUP,
INC. Defendants.


Filed October 17, 1995
Mercy and Finley: only 2 acute care
hospitals in Dubuque, Iowa propose to
merge.
Justice Department sues for preliminary
injunction.


Facts
Dubuque population = 86,403
Mercy: 320 staffed beds, average daily
census = 127.
Finley: 124 staffed beds, average daily
census = 63.

competition - outside 70m radius, but
within 100 m.
Madison, Wisconsin

Waterloo

Cedar Rapids

Iowa City, Iowa

Dubuque

Freeport, Illinois


Insurance coverage for Mercy/Finley
patients
 50%

Medicare/Medicaid

 25%

Fee-for-service (traditional indemnity)

 25%

Managed care (HMOs, PPOs)

Negotiated 15-30% hospital price discounts.


Justice Department case
1) Where do Dubuque patients go for
hospital care?
88% inside (Mercy or Finley)
12% outside
2) Where are Mercy/Finley patients from?
76% inside (Dubuque)
24% outside
 Dubuque

the relevant geographic market,
and merger constitutes a monopoly.


Ruling
District court judge rejects Justice
Department’s definition of geographic
market as too narrow.
 “The

government continues to fail to look at
the merger within the context of current
market trends. All evidence is that there is
a great deal of competition for health care
dollars…”

 “…if

DRHS [merged entity] reacted in a
noncompetitive manner, an HMO that
could successfully induce Dubuque area
residents to use alternative hospitals would
be at a significant cost advantage.”

 “There

is also evidence that managed care
entities can successfully induce Dubuque
residents to use other regional hospitals for
their inpatient needs.”

Merger of Mercy and Finley would
not/could not result in higher prices.


Case Study Conclusion
Even if only one hospital exists in a
given geographic region, it may not be
able to act as a monopolist
Ability of large, managed care buyers to
shift patients can keep the market
competitive.


Hospital Advertising
% of hospitals that advertise rose from

36% in 1995 to 50% in 1998.
We often see ads for local hospitals in
newspapers and magazines.
Why?


Dorfman-Steiner model of advertising
The profit-maximizing amount of advertising
occurs where:
Advertising Expenditures

Advertising Elasticity of  Demand

      Total Revenues                   Price Elasticity of  Demand

If Ea equals .2, then 1% ↑ in advertising → .
2% ↑ in demand.
And if EP equals 4, then Ea / EP 0.05
 To

max profits, hospital should spend 5% of total
revenues on advertising.


Hospital will spend more on advertising
when:
Ea is higher.
EP is lower.
↑

advertising costs $. But when demand is
less elastic with respect to price, these
costs can be passed onto the consumer.
 Hospitals with greater market power will
advertise more aggressively.


What type of advertising will
hospitals use?
Advertising the availability of services
that all hospitals have may ↑market
size, but not your own patient base.
Hospitals will use advertising to
differentiate their product.
 Hospital

rankings.
 Luxury services.


Hospital Conduct
Large #s of sellers and low barriers to
entry promote competition.
We expect increased competition to
lead to:
 Higher

output and quality.
 Lower price.

However, the hospital market has
important differences.
 Hospitals

don’t necessarily maximize

profits.
 Government is a major payer
Prices not set competitively.
 Consumer

less likely to shop around.

Insurance and asymmetric info.
•

Is hospital market competition good or
bad for consumers?


Markets with fewer hospitals may face
higher prices.
 But

hospitals in more concentrated markets
may be larger, and econ of scale may ¯
costs.

Look at price and quality effects of

hospital mergers.


Data from Los Angeles in 1990-1993
suggests that hospital mergers would ↑ prices
>5%.
(Town & Vistnes 2001)

Hospitals that merged between 1989 and
1996 lowered their costs two years after
consolidation relative to comparable hospitals
that didn’t merge
(Dranove & Lindrooth 2003)

Even if hospitals lower costs, they may not
pass price savings on to consumers.
 Hospitals

that merged in 1997-2001 raised their
negotiated PPO prices relative to the median
market price.


Other studies suggest that hospital
consolidation does not improve the
quality of care.
These results suggest that more
competitive hospital markets favor
consumers.

Does Ownership Type Affect
Conduct?
Empirical Evidence
 Prices

higher for for-profit hospitals, but
NFP & public hospitals enjoy tax
advantages, municipal bond discounts.
 Only small differences in costs by
ownership type.


But public hospitals provide more uncompensated care
Data from CA calls into question tax-exempt status of
NFPs.


Has managed care changed
conduct?
Empirical Evidence
 HMO

hospitalization rates 15-20% lower
than those of fee-for-service insurance
plans.
 However, HMO growth has not led to
decrease in total hospital costs per capita
at market level.

 Maybe

further HMO penetration required.
 Government still a dominant payer, and
reimburses generously.
 Maybe managed care doesn’t work.

Outcomes for patients covered by
HMOs similar & sometimes better than
those for fee-for-service patients.


Hospital Market Performance
Hospital Expenditures in the United States, 1960-2007
Total Hospital
Spending as a
Average Annual
Expenditures
Percentage of
Year
Change from
(billions of
Gross Domestic
Previous Period
dollars)
Product
1960
$ 9.3
___

1.8%
1970
27.6
11.6%
2.7
1980
101.0
13.9
3.6
1990
251.6
9.6
4.3
2000
417.0
5.2
4.2
2007
696.5
7.6
5.0

How have price and quantity changed?


Table 14-8 Hospital Price Inflation Trend in the United States 1975-2006
General Inflation Rate
(urban consumers)

Year

1975
1980
1984
1988
1990
1992
1996

9.1%
13.5
4.3
4.1
5.4
3.0
2.7

Hospital Room Inflation
Rate (urban consumers)

17.1%
13.1
8.3
9.3
10.9
8.8
4.5
Inpatient Hospital Services

1998

1999
2000
2001
2002
2003
2004
2005
2006

1.6
2.2
3.4
2.8
1.6
2.3
2.7
3.4
3.2

2.7
3.8
5.5
6.3
8.4
6.8
5.7
5.7
7.0

Source: U.S. Department of Labor, Bureau of Labor Statistics, CPI Detailed

Report (various issues).